Contango vs Backwardation: What is the difference and how to make money in both of them?

Learn difference between different future curves

The shape of the futures curve is important to commodity hedgers. Their strategy is dependent on whether commodity futures markets are contango markets or backwardation markets. These two curves are frequently mistaken for one another. 

What is Contango? 

A situation in which the futures price of a commodity is greater than the spot price is known as contango or forwardation. It usually occurs when an asset price is expected to rise over time. As a result, the forward curve slopes upward. Futures contract supply and demand affect the futures price at each available expiration. In contango, investors are willing to pay more for a commodity in the future. 

Ways to earn money from the contango market 

Arbitrage methods are one approach to profit from contango. An arbitrageur, for example, would buy a commodity at the spot price and then sell it at a higher futures price. The spot and futures price actually converge as expiration approaches due to arbitrage, and contango diminishes. There is also another approach to profiting from contango. Futures prices above the spot price can be a signal of higher prices in the future, particularly when inflation is high. Speculators may buy more of the commodity in contango in the hopes of profiting from higher predicted future prices. 

What Is Backwardation? 

Backwardation is when the current price of an underlying asset is higher than prices trading in the futures market. If the striking price of a futures contract is lower than the current spot price, it indicates that the present price is too high and that the predicted spot price will fall in the future. Backwardation is the term for this condition 

Ways to earn money from backwardation market 

It's important to understand the benefits and risks that come with backwardation. The investor can earn money from price imbalances by buying and selling assets in different markets.